What are Subchapter S Corporations, and What Owners are Eligible?

Perhaps you are starting a business, and have heard about a popular type of business entity known as a “subchapter S corporation.”  What, you may wonder, is a subchapter S corporation, and how is it different than a “regular” corporation?  And, is my business eligible?

The Legal Rights of a Subchapter S Corporation and Taxation

Legally, a subchapter S corporation is exactly the same is a “regular” corporation (sometimes also referred to as a “C” corporation).  Both types of corporations issue shares, they both are run by a board of directors and managed through officers.  Both types of businesses also provide the owners – the shareholders – with limited liability protection (in other words, the shareholders in most cases are not going to be liable for business debts).

For more information about limited liability protection, see “What Needs to be Done to Preserve Limited Liability Protection?

The primary difference between a “regular” corporation and a subchapter S corporation is the tax treatment.  Corporations that have elected to be taxed as a subchapter S corporations are not taxed at the corporate level.  Instead, income is allocated to shareholders, who are then taxed at their personal level.  “Regular” (or non-subchapter S) corporations are taxed at the corporate level, and shareholders are then taxed on any dividends distributed.

See – “Understanding the Taxation of Subchapter S Corporations”

Becoming a Subchapter S Corporation

In addition to the corporate formation, there are certain resolutions, steps, and a tax filing that must be made to establish subchapter S tax treatment.  Our firm helps individuals by drafting and filing the appropriate documentation.

Who May Be Shareholders of a Subchapter S Corporation?  Subchapter S Qualifications[1]

Subchapter S corporations are limited in terms of who may be a shareholder, and by other restrictions.  Subchapter S corporation shareholders can include:

• United States citizens and resident aliens
• Certain types of trusts (such as a revocable trust of the type often set up by individuals for tax planning purposes)

Shareholders of subchapter S corporations cannot include:

• Partnerships
• Corporations
• Non-US citizens who are not resident aliens

Other Subchapter S Qualifications

Subchapter S corporations are not available if:

• There are more than 100 shareholders
• The business of the corporation is of the type not permitted under subchapter S corporation regulations (such as financial institutions, insurance companies, and domestic international sales corporations)
• The corporation will have more than one class of stock

Is a Subchapter S Corporation Status Permanent?

The short answer is “no.”  If a corporation wishes to sell stock to a person or entity that does not qualify as a subchapter S shareholder, if it is wishes to sell additional classes of stock, or if for any other reason will cease to fall within the requirements for subchapter S corporations, the corporation continues business as usual.  The only effect is that after the “disqualifying event” the corporation will be taxed as a “regular” corporation; but everything else about the corporation will remain unaffected.

To Learn More, Please Call Our Firm

The foregoing discusses only a few of the basics for subchapter S corporations.  There are many tax and other factors that should be considered before choosing subchapter S corporation status; and generally it will be helpful to set up an appointment with an attorney and possibly a CPA to understand the ramifications of such treatment.

We would look forward to helping you understand whether a subchapter S corporation is best for you.